It was the big story of last week: how mid-caps have outperformed their large-cap peers by a wide margin. Even as traders bask in the sunshine of momentum gains, experts would be wondering whether this is fundamentally justified. Yes and no. A few reasons in favour of the yes. One, this bout of outperformance comes after a stretch of extremely poor breadth for the market. A period where a handful of index stocks kept pushing the market to higher levels even as individual portfolios languished. So much so that people had started wondering if such a narrow market rally was sustainable. Now, the opposite is happening. Large-caps have stalled as mid-caps catch up. In a sense, this would seem logical. What that preceding narrow move had also established was fairly rich valuations for the large-cap universe. Many index stocks were beginning to look not only fairly valued but in many cases, expensive. This may have expanded the valuation gap between large caps and mid-caps, which needed bridging. This argument, too, has some merit.
Having said this, the patterns of last week raise some red flags as well. Stocks hardly move 25-50 per cent in a single day to cover valuation differentials. It is true that some of the mid- and small-caps deserved to be at higher price points. Many had declared superlative results and had been ignored in the large-cap wave. It is the absolute blowouts that worry one. That smacks of trading froth and operator activity. A lot of stocks have made moves that are fundamentally unjustitifed, trading turnover in many stocks has been abnormally high with low attendant delivery volumes and additions in stock futures positions in some have been at unprecedented levels. This may carry on for a while longer but it is getting a bit dangerous.
Words of caution on mid-caps will fall on deaf ears now as it is truly difficult not to participate in such spectacular daily moves. However, investors should be careful about what prices they are paying to enter mid-caps now. It may not be wise to get into a stock after its market cap has suddenly jumped by a half for no apparent reason. A lot of "stories" will be doing the rounds as they typically do at such times, precisely because investors want to believe these stories now. People are at their most gullible when stocks are flying around on the screen. If you are trading, you need to be careful and disciplined. Sudden spikes are best encashed, even if you have to walk away leaving some gains on the table. Ask around, you will find many people stuck in Reliance Petroleum at Rs 280 or Essar Steel at Rs 70. For the nimble trader, there are gains to be made out here, but the risks are high. As long as you are aware of that, it is fine.
He is also the Executive Editor, CNBC-TV18